What is Tax Structure?
Tax Structure: Understanding Revenue Sensitivity in Montana Local Government Finance
Tax Structure
The link between the tax structure and the local economy is critical in determining the level of government expenditures that can be supported. In general terms, one can characterize a tax structure by dividing it into income-based taxes, sales and consumption taxes, and real property taxes.
1. Income‐based taxes, which include personal and business income taxes, are typically the most sensitive to the economy and will exhibit strong growth in economic expansions and sharp slowdowns in economic recessions.
2. Sales and consumption taxes generally show less volatility, yet still accelerate and slow down as the economy rises and falls.
3. Real property taxes, which in general grow at a fairly steady rate in both expansions and
contractions, show the least responsiveness to the local economy.
Local governments typically raise about 75 percent of their tax revenues from the real property tax, about 20 percent from sales and consumption taxes, and the remainder from income taxes. In a period of sharp economic expansion, this traditional structure will show limited acceleration in growth. If the growth in the economy creates strong demands for growth in expenditures, this revenue structure will create sizeable budget pressures. On the other hand, in a period of economic decline, this revenue structure will show a very limited decrease.
Obviously, complete stability is not the sole desirable characteristic of a revenue structure. The ability to grow with the economy, low cost of collection, and reasonable assurance that poor taxpayers do not bear a disproportionate share of the tax burden are also important.
The link between the tax structure and the local economy is critical in determining the level of government expenditures that can be supported. In general terms, one can characterize a tax structure by dividing it into income-based taxes, sales and consumption taxes, and real property taxes.
1. Income‐based taxes, which include personal and business income taxes, are typically the most sensitive to the economy and will exhibit strong growth in economic expansions and sharp slowdowns in economic recessions.
2. Sales and consumption taxes generally show less volatility, yet still accelerate and slow down as the economy rises and falls.
3. Real property taxes, which in general grow at a fairly steady rate in both expansions and
contractions, show the least responsiveness to the local economy.
Local governments typically raise about 75 percent of their tax revenues from the real property tax, about 20 percent from sales and consumption taxes, and the remainder from income taxes. In a period of sharp economic expansion, this traditional structure will show limited acceleration in growth. If the growth in the economy creates strong demands for growth in expenditures, this revenue structure will create sizeable budget pressures. On the other hand, in a period of economic decline, this revenue structure will show a very limited decrease.
Obviously, complete stability is not the sole desirable characteristic of a revenue structure. The ability to grow with the economy, low cost of collection, and reasonable assurance that poor taxpayers do not bear a disproportionate share of the tax burden are also important.